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-- Despite high debt leverage, we expect U.S. video relay service provider Sorenson Communications Inc. will generate positive discretionary cash flow and maintain adequate liquidity over the next 12 to 18 months.
-- We are assigning Sorenson a preliminary 'B-' corporate credit rating with a stable outlook. We are also assigning preliminary issue-level and recovery ratings to the company's proposed debt.
-- The stable outlook reflects our expectation that despite the potential for a lowering of rates pending a final FCC review, we expect the company to generate positive discretionary cash flow and that liquidity will remain adequate over the near term.
On Dec. 12, 2012, Standard & Poor's Rating Services assigned a preliminary 'B-' rating on Salt Lake City, Utah based Sorenson Communications Inc. The outlook is stable.
At the same time, we assigned the company's first out revolver due 2017 a preliminary 'B+' rating, with a preliminary recovery rating of '1', indicating our expectation for very high (90% to 100%) recovery for lenders in the event of a payment default.
We are also assigning the first-lien notes and term loan due 2020 a preliminary 'B-' rating, with a preliminary recovery rating of '3', indicating our expectation for meaningful (50% to 70%) recovery for bondholders in the event of a payment default.
We are also assigning the first-lien second out notes a preliminary 'CCC' rating, with a preliminary recovery rating of '6', indicating our expectation for negligible (50% to 70%) recovery for bondholders in the event of a payment default.
The preliminary 'B-' rating and stable outlook reflect our expectation that despite the company's high debt leverage, it will generate positive discretionary cash flow and maintain adequate liquidity over the next 12 to 18 months. Our rating incorporates uncertainty surrounding the potential that the FCC chooses to adopt a final reimbursement rate lower than the interim reimbursement rate of $5.07 per minute, an 18.8% reduction from the previous rate of $6.24. Under the interim rate structure, and taking into account the company's recent cost cuts and growth at Caption Call, we believe the company should continue to generate positive discretionary cash flow and maintain adequate interest coverage.
We regard the financial risk profile as "highly leveraged," based on the company's high pro form lease-adjusted debt-to-EBITDA ratio of greater than 5x and questions surrounding private equity ownerships long term financial policy. We view the company's business profile as "weak" based on its exposure to the regulatory reimbursement rate setting and potential that the market is in a mature state limiting future growth prospects. Our governance assessment is "fair."
Sorenson provides video relay services (VRS) that facilitate telephone communication for deaf and hard-of-hearing persons in the U.S. The company has entered the mature phase of its growth cycle due to high penetration levels in the serviceable market. This trend suggests that high-quality VRS is widely available within the deaf community and that new pockets of underserved customers may be more difficult to find. Additionally, the niche market for VRS services is getting more competitive as interim rates are higher for smaller competitors. The Caption Call business, a new service for the hard-of-hearing, is currently experiencing high growth rates, but there is uncertainty regarding the sustainability of current adoption rates as well as the potential for increase future competition.
For the remainder of 2012, we have assumed revenue and EBITDA could grow at a low-double-digit percent rate because of modest growth in VRS minutes and continued growth in Caption Call. In 2013, we expect a continuation of recent trends at Caption Call and have assumed a low-single-digit reduction in the rate from the interim level would likely lead to high-single-digit to low-double digit-percentage growth in revenue and EBITDA. For the third quarter ended Sept. 30, 2012, revenues and EBITDA increased 13% and 16%, respectively, led by modest 1.5% growth in VRS minutes and easy comparisons to last year as the new segment Caption Call contributed minimally last year. Sorenson's EBITDA margin remained healthy and increased over the last 12 months due to growth in the Caption Call segment and cost reduction efforts undertaken. Absent a significant change in rate, we expect the margin to modestly expand in 2013 as a result of recent cost-reduction efforts and near-term adoption of Caption Call.
As of Sept. 30, 2012, lease-adjusted total debt to EBITDA pro forma for the refinancing transaction was high, at 6x, down from 6.7x as a result of EBITDA growth. EBITDA coverage of interest was 1.8x up from 1.3x last year. Based on our base-case assumption of a modest reduction in rate in 2013 and growth in Caption Call, we believe that lease-adjusted total debt to EBITDA could decline to the mid-5x area in 2013. Going forward, we still project that the company will generate positive discretionary cash flow, although down from historical levels. Our rating is predicated on the assumption that the company will continue to generate positive discretionary cash flow and deleverage over time.
We believe the company has "adequate" liquidity to cover its capital needs over the next 12 to 18 months. Expectations and assumptions that support our liquidity assessment are as follows:
-- We expect sources of liquidity over the next 12 to 24 months to cover uses by 1.2x or more.
-- Net sources would be positive, even with a 15% to 20% drop in EBITDA over the next 12 months, in our view.
-- We expect Sorenson will have no maintenance financial covenants on term debt or notes.
-- Based on the company's current cash balances and availability under its revolving credit facility, we believe it could absorb low-probability, high-impact shocks over the coming year.
As of Sept. 30, 2012, Sorenson's liquidity sources pro forma for the transaction include cash balances of $10.4 million; healthy funds from operations that we expect could decline moderately over the next 12 months due to higher interest costs associated with the refinancing. We expect the company has full access under its proposed $27.5 million revolving credit facility due 2018. Uses of liquidity include manageable working capital usage and capital expenditures of about $45 million. There are no significant maturities until 2018, when the revolver comes due, and 2020, when its first-lien term loan, first-lien notes, and second-lien notes will come due. We expect Sorenson's credit agreement will contain no maintenance financial covenants.
See the recovery report on Sorenson, to be published in a separate report as soon as possible after this release.
The stable rating outlook reflects our expectation that Sorenson will generate positive discretionary cash flow and maintain adequate liquidity over the next 12 to 18 months. We could raise the rating if Sorenson can reduce leverage below 6x and if the final outcome of FCC review does not meaningfully impact Sorenson's ability to service its debt.
Conversely, we could lower the rating to the 'CCC' category if reimbursement rates are lowered more than our low-single-digit percent annual assumption over the next three to five years, or if we become convinced that a slowdown in growth of VRS minutes could lead to negative discretionary cash flow generation or interest coverage approaching 1x. We would also lower the rating if the proposed financing does not close.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Sorenson Communications Inc.
Corporate Credit Rating B- (prelim)/Stable/--
First out revolver due 2017 B+ (prelim)
Recovery Rating 1 (prelim)
First-lien nts and term loan due 2020 B- (prelim)
Recovery Rating 3 (prelim)
First-lien second out notes CCC (prelim)
Recovery Rating 6 (prelim)
* Euro firm near 5-1/2-month high vs dollar after French vote
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